Income Tax Act,1961

90. Agreement with foreign countries or specified territories.—(1) The Central Government may
enter into an agreement with the Government of any country outside India or specified territory outside
India,—
(a) for the granting of relief in respect of—
(i) income on which have been paid both income-tax under this Act and income-tax in that country or
specified territory, as the case may be, or
(ii) income-tax chargeable under this Act and under the corresponding law in force in that country or
specified territory, as the case may be, to promote mutual economic relations, trade and investment, or
(b) for the avoidance of double taxation of income under this Act and under the corresponding law in
force in that country or specified territory, as the case may be, or
(c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable
under this Act or under the corresponding law in force in that country or specified territory, as the case
may be, or investigation of cases of such evasion or avoidance, or
(d) for recovery of income-tax under this Act and under the corresponding law in force in that country
or specified territory, as the case may be, and may, by notification in the Official Gazette, make such
provisions as may be necessary for implementing the agreement.
(2) Where the Central Government has entered into an agreement with the Government of any country
outside India or specified territory outside India, as the case may be, under sub-section (1) for granting
relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to
whom such agreement applies, the provisions of this Act shall apply to the extent they are more
beneficial to that assessee.
2[(2A) Notwithstanding anything contained in sub-section (2), the provisions of Chapter X A of the Act
shall apply to the assessee even if such provisions are not beneficial to him.] (3) Any term used but not
defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise
requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning
as assigned to it in the notification issued by the Central Government in the Official Gazette in this
behalf.
(4) An assessee, not being a resident, to whom an agreement referred to in sub-section (1) applies, shall
not be entitled to claim any relief under such agreement unless 2[a certificate of his being a resident] in
any country outside India or specified territory outside India, as the case may be, is obtained by him
from the Government of that country or specified territory.
5 The assessee referred to in sub-section (4) shall also provide such other documents and information,
as may be prescribed.] Explanation 1.—For the removal of doubts, it is hereby declared that the charge
of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is
chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign
company. Explanation 2.—For the purposes of this section, ―specified territory‖ means any area
outside India which may be notified as such by the Central Government.
4[Explanation 3.—For the removal of doubts, it is hereby declared that where any term is used in any
agreement entered into under sub-section (1) and not defined under the said agreement or the Act, but
is assigned a meaning to it in the notification issued under sub-section (3) and the notification issued
thereunder being in force, then, the meaning assigned to such term shall be deemed to have effect from
the date on which the said agreement came into force.]
5[Explanation 4.—For the removal of doubts, it is hereby declared that where any term used in an
agreement entered into under sub-section (1) is defined under the said agreement, the said term shall
have the same meaning as assigned to it in the agreement; and where the term is not defined in the said
agreement, but defined in the Act, it shall have the same meaning as assigned to it in the Act and
explanation, if any, given to it by the Central Government.]
6[90A. Adoption by Central Government of agreement between specified associations for double
taxation relief.—(1) Any specified association in India may enter into an agreement with any specified
association in the specified territory outside India and the Central Government may, by notification in
the Official Gazette, make such provisions as may be necessary for adopting and implementing such
agreement— (a) for the granting of relief in respect of— (i) income on which have been paid both
income-tax under this Act and income-tax in any specified territory outside India; or (ii) income-tax
chargeable under this Act and under the corresponding law in force in that specified territory outside
India to promote mutual economic relations, trade and investment, or (b) for the avoidance of double
taxation of income under this Act and under the corresponding law in force in that specified territory
outside India, or (c) for exchange of information for the prevention of evasion or avoidance of income-
tax chargeable under this Act or under the corresponding law in force in that specified territory outside
India, or investigation of cases of such evasion or avoidance, or 431
(d) for recovery of income-tax under this Act and under the corresponding law in force in that specified
territory outside India. (2) Where a specified association in India has entered into an agreement with a
specified association of any specified territory outside India under sub-section (1) and such agreement
has been notified under that sub-section, for granting relief of tax, or as the case may be, avoidance of
double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this
Act shall apply to the extent they are more beneficial to that assessee.
2A Notwithstanding anything contained in sub-section (2), the provisions of Chapter XA of the Act
shall apply to the assessee even if such provisions are not beneficial to him.] (3) Any term used but not
defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise
requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning
as assigned to it in the notification issued by the Central Government in the Official Gazette in this
behalf.
4 An assessee, not being a resident, to whom the agreement referred to in sub-section (1) applies, shall
not be entitled to claim any relief under such agreement unless 3[a certificate of his being a resident] in
any specified territory outside India, is obtained by him from the Government of that specified territory.]
5 The assessee referred to in sub-section (4) shall also provide such other documents and information,
as may be prescribed.] Explanation 1.—For the removal of doubts, it is hereby declared that the charge
of tax in respect of a company incorporated in the specified territory outside India at a rate higher than
the rate at which a domestic company is chargeable, shall not be regarded as less favourable charge or
levy of tax in respect of such company. Explanation 2.—For the purposes of this section, the
expressions— (a) ―specified association‖ means any institution, association or body, whether
incorporated or not, functioning under any law for the time being in force in India or the laws of the
specified territory outside India and which may be notified as such by the Central Government for the
purposes of this section; (b) ―specified territory‖ means any area outside India which may be notified
as such by the Central Government for the purposes of this section.
5[Explanation 3.—For the removal of doubts, it is hereby declared that where any term is used in any
agreement entered into under sub-section (1) and not defined under the said agreement or the Act, but
is assigned a meaning to it in the notification issued under sub-section (3) and the notification issued
thereunder being in force, then, the meaning assigned to such term shall be deemed to have effect from
the date on which the said agreement came into force.] 432
1[Explanation 4.—For the removal of doubts, it is hereby declared that where any term used in an
agreement entered into under sub-section (1) is defined under the said agreement, the said term shall
have the same meaning as assigned to it in the agreement; and where the term is not defined in the said
agreement, but defined in the Act, it shall have the same meaning as assigned to it in the Act and
explanation, if any, given to it by the Central Government.
91. Countries with which no agreement exists.—(1) If any person who is resident in India in any
previous year proves that, in respect of his income which accrued or arose during that previous year
outside India (and which is not deemed to accrue or arise in India), he has paid in any country with
which there is no agreement under section 90 for the relief or avoidance of double taxation, income-
tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction
from the Indian income-tax payable by him of a sum calculated on such doubly taxed income at the
Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of
tax if both the rates are equal. (2) If any person who is resident in India in any previous year proves that
in respect of his income which accrued or arose to him during that previous year in Pakistan he has paid
in that country, by deduction or otherwise, tax payable to the Government under any law for the time
being in force in that country relating to taxation of agricultural income, he shall be entitled to a
deduction from the Indian income-tax payable by him— (a) of the amount of the tax paid in Pakistan
under any law aforesaid on such income which is liable to tax under this Act also; or (b) of a sum
calculated on that income at the Indian rate of tax; whichever is less. (3) If any non-resident person is
assessed on his share in the income of a registered firm assessed as resident in India in any previous
year and such share includes any income accruing or arising outside India during that previous year
(and which is not deemed to accrue or arise in India) in a country with which there is no agreement
under section 90 for the relief or avoidance of double taxation and he proves that he has paid income-
tax by deduction or otherwise under the law in force in that country in respect of the income so included
he shall be entitled to a deduction from the Indian income-tax payable by him of a sum calculated on
such doubly taxed income so included at the Indian rate of tax or the rate of tax of the said country,
whichever is the lower, or at the Indian rate of tax if both the rates are equal. Explanation.—In this
section,—
(i) the expression ―Indian income-tax means income-tax 2*** charged in accordance with the
provisions of this Act;
(ii) the expression ―Indian rate of tax‖ means the rate determined by dividing the amount of Indian
income-tax after deduction of any relief due under the provisions of this Act but before deduction of
3[any relief due under this Chapter], by the total income; (iii) the expression ―rate of tax of the said
country‖ means income-tax and super-tax actually paid in the said country in accordance with the
corresponding laws in force in the said country after deduction of all relief due, but before deduction of
any relief due in the said country in respect of double taxation, divided by the whole amount of the
income as assessed in the said country; 433
(iv) the expression ―income-tax‖ in relation to any country includes any excess profits tax or business
profits tax charged on the profits by the Government of any part of that country or a local authority in
that country
Double Taxation Relief

Relief from double taxation can be provided under two ways namely exemption method and tax credit
method. Under the exemption method, specific income is taxed in one of the two countries and
exempted in another country. Under the tax credit method, the income is taxed jointly with the countries
mentioned in the income tax treaty, in addition to the country of residence. This will authorize the tax
credit or deduction for the tax charged in the country of residence.

Section 90 of the Income Tax Act

Section 90 of the Income Tax Act is associated with relief measures for assesses involved in paying
taxes twice i.e. paying taxes in India as well as in Foreign Countries or territory outside India. Section
90 also contains provisions which will certainly enable the Central Government to enter into an
agreement with the Government of any country outside India or a definite territory outside India.
Section 90 is intended for granting relief with reference to any of the following relevant situations that
may occur:

• Income on which tax has been paid both under Income Tax Act, 1961 and Income Tax
prevailing in that country or definite territory.
• Income tax chargeable under Income Tax Act, 1961 and according to the corresponding law in
force in that country or specified territory to boost mutual economic relations, trade and
investment.
• For the prevention of double taxation of income under Income Tax Act, 1961 and under the
equivalent law in force in that country or specified territory.
• For exchange of information regarding the avoidance of evasion or avoidance of income-tax
chargeable as per Income Tax Act, 1962 or under the equivalent law in force in that country or
specified territory, or investigation of cases of evasion or avoidance.
• For recovery of income tax under the Income Tax legislation which is in force in India and
under the equivalent law in force in that country of the specified territory.
• The double tax relief as per Section 90 can be claimed only by the residents of the countries
who have entered into the agreement. If a resident of other countries wants to claim relief related
to the phenomenon of double taxation, then they have to obtain a Tax Residence Certificate
(TRC) from the government of a particular country.

History and Background of DTAA

In 1899 Prussia and Austro Hungarian Empire for the first time entered into the double taxation
avoidance agreement. In the 13th century first time the double taxation relating issue was raised among
France and Italy. The issue was “the property to be taxed was situated in one state but the owner of the
property was a resident of the state. The concept of providing the relief from double taxation comes on
the scene in 1939 when the income-tax (double taxation relief) (Indian states) rules were framed. It was
felt that the necessity to have a model agreement which can be a good reference in framing double
taxation avoidance agreement between two foreign states. That is how The League of Nations
introduced the first model bilateral convention in 192810. After that in 1943 the model convention of
Mexico and in 1946 the London model convention was getting introduced. Later in 1956 the council of
the organization for European economic cooperation established a fiscal committee to formulate a
model convention. In 1963 for the very first time the first draft “double taxation convention on income
and capital was enacted. Finally in 1977 OECD model convention and commentaries come into
existence. In 1992 OECD published model convention.

Under this Double Taxation Avoidance Agreement Mauritian-based companies selling shares of Indian
companies are effectively exempt from capital gains tax. This encouraged tax avoiders to route
investments into India through Mauritius based shell companies, leading to lots of tax revenue foregone.
Official data states that over the 15 year period from 2000-2015, the highest amount (34%) of total
Foreign Direct Investment into India was from Mauritius, valued at US$ 93.6 billion.
What Basically Happened

This treaty has now been amended after years of negotiations between the two countries. From 2017,
Mauritian investors will be taxed on capital gains at half the Indian rate (meaning 7.5%) till 2019, after
which the full rate will apply. This basically removes the incentive for tax avoiders to route funds
through Mauritius as they will be taxed anyway. In that sense it plugs a major loophole. It is also one
of the remedies sought in my essay and it is a stroke of good fortune that action on the issue has been
taken so quickly.

Shell companies are exempt from the half rate during the two year transition period. If a Mauritian
resident company has spent less than 1.5 million Mauritian Rupees on operations in the preceding year,
it will be deemed a shell company. This is a rigorous definition and will include almost all shell
companies.

The government has announced that it will now rework (on similar lines) its Double Taxation
Avoidance Agreement with Singapore, another major tax haven and the second biggest source of
Foreign Direct Investment after Mauritius.

The positives

A major loophole has been plugged, so the amount of tax revenue lost through the ‘Mauritius route’
should decrease.

This will provide more resources to the government to carry out developmental activities such as
building more schools.

Other governments around the world can take inspiration/warning. A historic litigation is unfolding in
Kenya, where the government is being taken to court for its tax-abuse-enabling Double Taxation
Avoidance Agreement with…Mauritius.

It’s also a victory for the ‘source-based’ principle of taxation, which states that tax should be levied
where the money is made, as opposed to where the company is based (which is what the ‘residence-
based’ principle states). The residence-based principle works to the advantage of rich countries, where
most large corporations are headquartered, to deprive poor countries of their fair share of taxes.

The not-so-positives

It seems that other securities – mutual funds, exchange-traded derivatives and convertible or non-
convertible debentures, to name a few – will be exempt. Thus other options for investing illicit cash
remain. All eyes will now be on the contents of the long-pending General Anti-Avoidance Rules.
Its application is prospective, not retrospective – meaning farewell to the money lost so far.

Mauritius (and Singapore) are the biggies, but by no means the only ones. Avoiders will likely shift to
other havens, such as the Netherlands or British Virgin Islands.

Despite these drawbacks, this is a big step forward and certainly a boost to the global effort on tax
havens. An intergovernmental tax commission in the UN is needed now more than ever to catalyse
these individual efforts and enable globally coordinated and consistent action against tax havens.

So what’s happened since then?

After India renegotiated its double tax avoidance agreement with Mauritius in 2016, there have been
some positive developments. First, a quick recap: the essence of the 2016 renegotiation was to plug the
key loophole that made Mauritius a preferred investment route into India. The loophole was “residence
based taxation of capital gains arising from alienation of shares.” Shorn of jargon, what that means is
that if a Mauritius based company invested in shares of a company resident in India, and it sold those
shares later and made a profit, then it would have to pay capital gains tax in Mauritius. Conveniently
enough, Mauritius doesn’t levy any capital gains tax! This loophole was plugged in 2016 and henceforth
there would be source based taxation of capital gains. Meaning that if Mauritius based companies sold
shares in a company resident in India, the capital gains tax would be collected by India.

Fast forward to today. The changes were to kick in fully from 1 April 2019. Hence, was there any
change in the meantime? Was there a mad scramble by tax-avoiding investors to flee Mauritius in the
face of impending doom? The answer, satisfyingly, is yes.

From 2017 to 2018, there was a precipitous drop in Foreign Direct Investment equity inflows from
Mauritius. In 2017, Mauritius accounted for a staggering 44% of total Foreign Direct Investment equity
inflows into India, valued at USD 9.8 billion. A year later, this number plummeted to USD 3 billion,
accounting for only 15% of inflows. In other words, inflows dropped by three times in a single year.

This raises another question: where did these funds go? Some of these may have gone to Singapore.
Inflows from Singapore during the same period doubled. In 2017, Singapore was the second biggest
source of inflows, accounting for 20% valued at USD 4.5 billion. A year later this number doubled to
USD 8 billion, which in 2018 was 40% of Foreign Direct Investment equity inflows. In 2019, Singapore
remains the largest source by far.

This is somewhat puzzling because in 2016, India also renegotiated its double tax avoidance agreement
with Singapore to plug the exact same loopholes as existed with Mauritius, which was residence based
taxation of capital gains arising from selling shares. Perhaps Singapore’s other strengths as a financial
hub such as the ability for companies to raise funds at comparatively lower rates and an effective dispute
resolution system continue to make it a preferred place for Indians to setup companies.

Other jurisdictions that also saw major increases in sending Foreign Direct Investment to India are Japan
(whose share tripled from 3% in 2017 to 9% in 2018) and the UK (whose share quadrupled from 1% to
4%). Interestingly, the Netherlands, which is another big source and a not-so-secret tax haven, saw its
share decline from 8.6% to 7.7%. This is despite the Double Taxation Avoidance Agreement with
Netherlands left untouched.

Coming back to the main story – the tremendous shift of capital away from Mauritius definitively proves
that the tax exemptions it offered, and the ease of establishing shell companies (the two key elements
of the Double Taxation Avoidance Agreement with India that were amended in 2016) were the main
reasons why it was a capital exporter. With these benefits gone, Mauritius’ utility declined considerably.
India’s effort in renegotiating the treaty to close off at least one route for tax avoidance, which was
backed by political will at the highest levels, seem to have paid off.

DTAA and Jurisdictional Issue

The main jurisdictional issue regarding double taxation avoidance agreement comes when the question
arises that “who can tax the income”? It means it is essential first to find out which country should tax
a particular income. If one country has entered into a double taxation avoidance agreement with another
foreign country then the question is who will tax the particular income:

1. The country from where the income comes.

2. The country where the taxpayer resides.

If it is provided in the DTAA that in case of immovable property; the country where the property was
located, has the right to tax. Here the question comes that the country where the owner lives can also
tax the same income. In such case the owner of the property shall have to claim “credit in the country
where he resides for the tax paid in the country where the property is located”.
In case of “business profits”, “the country of residence” has a right to tax the profit which is derived
from the business house; unless it is doing business in other source state and having a permanent
established located therein. The Madras high court in CIT vs. V.R.S.R.M Firm & Others and the
Karnataka High Court in the case CIT vs. R. M. Muthaiah in both these cases it was held that when it
is stated that tax can be charged for a certain income by one state then the other contracting state has no
right to tax on the same income. In general case both the contracting state has a right to tax income in
respect of “dividend and interest”; but the taxation right is vested in the state where the party resides
but it’s also stated that such income “also” be taxed in the source state. In OECD model convention
there are two articles 23A and 23B in this regard.

DOUBLE NON TAXATION AND TREATY SHOPPING: THE MISUSE OF DOUBLE

TAXATION AVOIDANCE AGREEMENT: AN ANALYSIS

In this chapter I will analyse the negative effect of double taxation avoidance agreement.

DTAA can be misuse by two ways, these are:

Double Non Taxation

Treaty Shopping

Double Non Taxation

Firstly I would like to discuss about the double non taxation. In case double non taxation a specific
income is not taxed in the source country, because of “an incentive”, “exemption” or “prevailing” in
that country.

Hypothetical Example

If a person who lives in India has an immovable property in country X. In country X the income which
comes from immovable property “may be” tax in accordance with the DTAA but the law of country X
does not provide for any tax of the income from such immovable property for some specific reason,
then such income will be “untaxed”; because of this reason that country X does not impose any tax on
the immovable property. But DTAA should not be interpreted in such way that it allows double non
taxation; because the purpose of DTAA is to avoid double taxation not to promote double non taxation.
So it can be said that the country of the resident has “inherent right” to tax the income of the resident.
If it is so then in the above example country X does not impose tax on the income from immovable
property; in that case India can tax the same income as it is the country of residence. But situation is
not as easy as it seems. A DTAA should be interpreted according to its own term even it is “result in
double non taxation”. The Supreme Court also stated that the double non taxation possibility is not
relevant.In the famous case CTI v. Laxmi Textile Exporters Ltd, the assessee is the Indian resident and
in Srilanka he owns a business which is a permanent establishment. That income is not considered as
taxable income in Sri-lanka. The Mardas High Court held that India would not tax this income as it is
a country of resident.

Treaty Shopping

Treaty shopping is another example of misuse of DTAA. It means when an assessee wants to do “a
transaction through another country which has most beneficial treaty with India in order to reduce his
tax liability.”

Example: Indo-Mauritius Treaty.

In India 40% of the total FDI comes through Mauritius, because according to the Indo Mauritius DTAA,
tax levied on capital gain as per the law of the country of the residence of the assessee. But according
to the tax law on Mauritius there is no tax imposed on capital gains; because of which all the investment
in India from the different country comes through the Mauritius.In the famous case Union of India v.
Azadi Bachao Andolan; it was held that if the aim of the DTAA was not to include a person of third
country and restricts him/her from taking “the benefit out of the favourable terms”, then there should
be an another provision about it. Parliament has a duty to take care of it in this regard; and if there is no
specific provision and limitation mentioning DTAA; then “no one can be denied benefit of the
favourable tax provision in the belief that treaty shopping is prohibited.”

Example: In the Indo-US DTAA Art 24 deals with treaty shopping.